Winners and Losers When Rates Start Moving Higher

The Federal Reserve is going to start raising interest rates. It may happen next week. It may happen next month. Or it may happen next year. But eventually the Fed is going to start raising interest rates for the first time in nearly a decade.

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When it does there will be winners and losers, those who stand to gain from the higher borrowing costs that will follow the rate hike and those who stand to lose. Here’s a list of the winners and losers, with an assist from Bankrate.com’s chief financial analyst Greg McBride.

Winners:

Banks will benefit because higher interest rates will “breathe life” into their net interest margins, or the difference between what banks pay depositors on their savings accounts and the rates the banks earn from borrowers. Net interest margins “have been squeezed” during the nearly seven years of near-zero interest rates.

Insurance companies because the higher return they will generate on their short-term investments can be used to help pay out future claims.

Pension funds because the higher returns they receive on their investments can be used to make payments to retirees whose specific payouts have already been established by contracts often signed years ago.

Consumers/savers, “but only slightly,” according to McBride, because many banks will likely fail to pass along the higher rates to savings depositors. Consequently, savers will benefit only if they shop around for the best rates on savings accounts and certificates of deposit (CDs).

Losers:

Consumers/borrowers because whether it be for a home, a car or big ticket appliance, the cost of borrowing will start to rise once the Fed pulls the trigger and starts raising rates.

Businesses/borrowers, especially small businesses working on a tight budget, because it will be more expensive to borrow money for capital improvements or expansions.

Anyone carrying debt tied to an adjustable-rate mortgage, a home equity line of credit or a credit card because all of those rates are tied to short-term rates that will mimic whatever direction the Fed moves.

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Keep in mind, however, that the initial increase, whenever it’s announced, will almost certainly be minimal, raising rates from their current near-zero range to a range of 0.25%-0.50%, which McBride said will have an “almost inconsequential effect on the household budget.”

The significance to most borrowers of that initial rate hike will be similar to “the first dusting of snow in late fall, it will signify a change in seasons,” said McBride.

What will matter, according to McBride, is what happens in the 18 to 24 months that follow that initial hike. The cumulative effect on borrowers, both consumers and businesses, “could be significant” if the Fed pushes rates higher rapidly and borrowers see their monthly payments rise sharply in tandem with the Fed’s moves.

But a rapid rise in interest rates is extremely unlikely, unless inflation takes a decided turn for the worse in the next year or so. And there’s been no indication that’s going to happen.

Fed policy makers may not agree over the timing of a rate hike – some would prefer to delay while others believe rates already should have moved higher – but they do agree on the trajectory.

Members of the policy-setting Federal Open Market Committee have repeatedly stressed that rates will move higher “gradually” once they pull the trigger on liftoff. “Too much emphasis is placed on the timing of the first increase. What matters is the entire path of rates,” Fed Chair Janet Yellen said during a press conference that followed the central bank's June meeting.

Those sentiments have been reiterated by influential Fed voices from both sides of the timing argument ever since.